Question

2. What are the two reasons liquidity risk arises? How does liquidity risk arising from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance sheet? What is meant by fire-sale prices?

Answer 1

1) When there is not enough cash or cash equivalents with the company to pay short term obligations like debts and perform daily operations then there is a liquidity crisis occur.

2) Liabilities are not your to own. When there is a liquidity crisis then because of the bad health the value of your assets fall down sharply while there is no fall in the liability. As assets = liability + equity and assets fell so the equity also decreases. Because you owe liability it doesn't change when there is a liquidity crisis.

3) When the company goes bankrupt the assets are needed to be sold instantly they are sold for very less compared to their intrinsic value. This is called fire sale prices. Prices are which are too low in situations of liquidity crisis and bankruptcy.